Buy, Sell or Hold: Nucor Corp.

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SeveralMoney Morningreaders have written to ask about steel-sector stocks, which have taken investors on a roller-coaster ride in the past year. After analyzing the sector, I came to one very strong conclusion: With its terrific fundamentals, Nucor Corp. (NYSE: NUE) is poised for significant gains.

Steel stocks, which had seen a 36% climb this year, have sold off dramatically and are now down about 16% for the year. That's a 42% drop from their peak. Wow!

Shares of the Charlotte, N.C.-based Nucor could not escape the carnage and have endured an even bigger swing: From their low of $50.30 a share in early January, the shares of the No. 1 U.S. steelmaker soared 66% to a trade at a high of $83.56. From their peak, Nucor's shares have declined 42%, closing Friday at $48.45. They're down 18% for the year.

This sell-off came on the heels of spectacular second-quarter earnings, where earnings per share jumped 70% to $1.94 a share on the back of major strengthening in global steel prices. The disappointment came from a charge to inventory and forward-looking guidance of $1.80 to $1.85 a share, which was below Wall Street's expectation of $1.91 a share.

Nucor remains one of the most admired companies in the steel sector, thanks to its superb management, ability to innovate, unquestionable leadership in the mini-mill steelmaker sector, and its disciplined business model.

Wall Street has soured on the overall steel sector. Just last Thursday, investment banking giant Goldman Sachs Group Inc. (GS)downgraded the sector from "Attractive" to "Neutral." It maintained its "Buy" rating on both Nucor and United States Steel Corp. (X), but removed the latter from its "Conviction Buy" list.

The million-dollar question is this: Are we trying to catch a falling knife, or are we poised to capitalize on a superb buying opportunity? Unlike most cases, in which a good argument can be made either way, the answer here is very clear-cut.

Indeed, the situation with Nucor's shares stands as an interesting case study of how Wall Street – and the financial markets in general – can overlook the profit opportunities that are then left for us to discover. In this case, in fact, Nucor may actually have created the profit play.

Let me show you just what I mean.

Among other peculiarities of Goldman's shift in opinion, coming after such a spectacular decline – where sector coverage was transferred from one analyst to another – was the investment bank's recognition that the "valuations of some of these stocks reflect a doomsday scenario, which we believe is not what longer-term fundamentals suggest."

I could not agree more with this last assessment.

You see, I have been calling my many contacts at hedge funds, on Wall Street, and with local businesses in New York, Brazil and even China to find out exactly what the global situation is with respect to steel demand, and steel prices.

Yes, here in the United States, car sales of 13 million are a temporary disaster. But the needs in terms of infrastructure are huge. And construction of condos, which seemed doomed not so long ago, will reignite pretty soon.

Prices in the real-estate bubble areas have collapsed, and lenders have taken already huge losses. Multi-billion-dollar funds, which had been waiting up to three years to start deploying their capital, are starting to invest, and are buying entire buildings at discounts of as much as 50 cents on the dollar. And even the noted doomsday prophesier – PIMCO manager William H. "Bill" Gross – recognizes that investing in distressed mortgages represents an interesting investment opportunity.

Indeed, this is actually an understatement: When you are one of the only bidders in the market, and the banks are forced sellers, you can name your price. And current prices of distressed mortgages have incredible discounts to the financial model prices in normal conditions, guaranteeing great returns for buyers. These and other de-leveraging sales and recapitalizations are ultimately cleaning up the balance sheets of banks and allowing them to return to and resume their regular and profitable bread-and-butter lending business. Non-residential construction and other steel-consuming manufacturing have barely slowed down – and in some cases are actually increasing due to strong export growth.

No wonder the U.S. economy grew at a 3.3% clip in the second quarter. The August payroll numbers indicate that it is growing at 2% or more, without counting the effect of the fiscal stimulus. The relatively weak – but by no means recessionary – job picture guarantees that interest rates will remain on hold (at current low levels) for quite some time, helping the U.S. economy out of the temporary slump.

On the international front, my conversations with locals and other business reports I reviewed present a mixed bag for steel prices: Let's take a look at the steel outlook in key markets around the world.

In Brazil, there is an imbalance between the supply and demand for slab steel that will take five years to fill.

China has slowed a bit – reaching high single-digit rates – due to the shutdown of factories and electricity in the major cities. But this was temporary, part of an overall strategy intended to clean the air and reduce overcrowding for the Summer Olympic Games. But all these activities are being restarted, even as we speak. China's energy needs keep growing exponentially, which bodes well for the demand for steel for the new power plants. Out in China's provinces, these needs are even more critical today, demanding that the construction of new plants and transmission lines – all of which require steel – get under way immediately. China's Baosteel Group Corp. barely reduced prices to deal with its temporary oversupply. Japan and India did the same.

The Middle East slowed down construction for the summer, as usual, given the high temperatures and other seasonal factors. But South Korea's steelmaking leader, POSCO Ltd. (PKX), a favorite of U.S. investing guru Warren Buffett, saw no need to reduce prices. And Germany's Salzgitter AG actually has increased prices, despite all the news about a supposedly slowing economy.

And while India's economy has seen its growth slow to a still-robust annual pace of 7% to 8%, new steel mills are being planned in order to be able to keep up with that country's massive infrastructure needs, for which no slowdown is seen.

The bottom line is that what we have seen is panic selling due to tax strategies and hedge-fund liquidations. This is due mainly to very poor hedge fund performance this year, which is prompting the liquidation and dissolution of some. There's also selling by hedge-fund managers who wish to take advantage of this year's low capital-gains taxes, since investors dread the possibility of having to pay much higher tax rates next year, should a Barack Obama administration take the White House in this November's presidential election.

Hedge fund selling not only affects stocks – it affects currencies, too. And hedge fund moves have contributed to the recent rally in the U.S. dollar.

This dollar strength has helped stoke fears that U.S. steelmakers would lose their cheap-dollar competitive advantage over foreign steelmakers, especially those from Asia.

Even on Wall Street, however, a few players have been shrewd enough to see the same scenario that we're predicting.

Citigroup Inc. (C)maintained its "Buy" rating on Nucor's shares, noting that "steel [stocks] have been punished amid the China slowdown and [the] crude-induced exodus from commodities. Yet underlying steel markets are far more solid," especially in the market for steel sheets, beams, bars and plates – Nucor strengths, and markets where prices remain at, or near, record highs.

Citi actually sees the potential for an earnings surprise in either the third or fourth quarter, and believes earnings for this year and next will exceed current Wall Street expectations – results that, if true, will likely cause Nucor's shares to shoot higher.

All the technical indicators – as well as the fundamental indicators related to valuation – point to a massively oversold condition in Nucor's shares specifically, and the steel sector in general. The panic selling that created this oversold condition has created a profit opportunity of which investors should take full advantage.

At current levels, Nucor's shares feature a very nice dividend yield of 2.64%. The firm, which has paid 141 consecutive quarterly dividends, just declared a "special" dividend of 20 cents a share – in addition to its 32-cent-a-share cash dividend – payable to shareholders of record as of Sept. 30.

[Editor's Note: Horacio Marquez was working as a vice president of the Merrill Lynch Emerging Markets Fixed Income Group in 1994 when he correctly predicted that both Argentina and Mexico were headed for currency crises – cementing his reputation as an expert on both the emerging markets and on the nuances of global finance. Now Marquez brings that expertise to you with his newly created "Shadow Stock Trader" service. To find out how to subscribe, please click here. "Buy, Sell or Hold" is a new Money Morning feature that has most recently analyzed such companies as Berkshire Hathaway Inc. (NYSE: BRK.A, BRK.B), Cisco Systems Inc. (Nasdaq: CS), Chevron Corp. (NYSE: CVX), Valero Energy Corp. (NYSE: VLO), General Electric Co. (NYSE: GE), and Chesapeake Energy Corp. (NYSE: CHK).]

** Special Note of Disclosure: Horacio Marquez holds no interest in Nucor Corp.

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